European Central Bank sets record rate hike to fight energy price shock

CNN: The European Central Bank is hiking interest rates by record three-quarters of a percentage point as it scrambles to contain the inflationary fallout from Russia›s invasion of Ukraine and the ensuing energy crisis. 

The move will take the benchmark rate for the 19 countries using the euro to 0.75 percent. It follows the central bank’s first hike since 2011 in July, when rates were increased to zero after years in negative territory. 

“The Governing Council took today’s decision, and expects to raise interest rates further, because inflation remains far too high and is likely to stay above target for an extended period,” the ECB said in a statement. 

Eurozone inflation hit 9.1 percent in August, driven by the soaring cost of energy and rising food prices. 

Europe has been trying to wean itself off Russia’s fossil fuel exports since the invasion in February. Moscow has responded by slashing flows of natural gas to Germany and other EU countries — sending prices soaring and forcing governments to spend hundreds of billions subsidizing bills for businesses and households.

Decades-high inflation is already taking its toll: recent surveys suggest that business activity fell in August for the second straight month, with Europe’s biggest economy — Germany — suffering a particularly marked decline. The region’s gross domestic product, the broadest measure of its economy, could shrink in the third quarter. Economists are warning that a European recession is looming.

But the central bank is worried that the energy price shock is already feeding expectations for higher inflation in the medium term. That could make the task of bringing it back to the ECB target rate of 2 percent significantly more difficult.

“Price pressures have continued to strengthen and broaden across the economy, and inflation may rise further in the near term,” the ECB said. 

It now expects inflation to average 8.1 percent this year, and 5.5 percent in 2023, up sharply from its previous forecasts. Economic growth, meanwhile, would come in weaker than it was expecting at 3.1 percent this year, and just 0.9 percent next year.

“There seems universal agreement that higher rates are required to prevent higher inflation becoming embedded, though [Russian] President Putin is creating a lot of slack in the European economy already,” said Kit Juckes, a strategist at Societe Generale.